Vishy Tirupattur 5.0 4 ideas

The private credit ecosystem is undergoing a real-time stress test with elevated redemption requests (e.g., Oaktree fund saw 8.5%). Default rates are projected to rise to 8%. Redemption pressure, concentrated in the retail channel (BDCs), tests the structural liquidity features of the asset class. Higher defaults, particularly in the software sector due to AI disruption, are a medium-term risk. The combination of near-term liquidity stress and a coming default cycle makes the asset class unattractive and risky. Institutional flows remain stable, and redemption caps are enforced as intended, preventing a systemic fire sale.

BDC exposure to software sector is about 26%... originated in 2021... more like a B minus or below type of credit... market is not confronted with how much of disruption is going to be there. Business Development Companies heavily financed lower-tier, highly leveraged software companies at the peak of the 2021 market. As AI disrupts these legacy software business models, these companies will struggle to service debt or refinance in 2027, leading to a spike in private credit defaults. The risk premium in private credit is too narrow and does not accurately price in the existential threat AI poses to the underlying software borrowers that make up a quarter of BDC portfolios. If AI disruption takes longer to materialize than expected, these BDCs will continue to collect high interest payments, punishing short sellers with high dividend yields.

The market has to deal with a massive amount of supply, $1 trillion of net issuance in the US investment grade market this year... we expect the markets to widen something in the 15 basis point range. Hyperscalers need to fund an unprecedented $750 billion to $900 billion in AI data center CapEx. They will tap the investment-grade corporate bond market to do this, and this massive flood of new bond supply will drive prices down and yields up. The sheer volume of incoming debt issuance required to build AI infrastructure will mechanically widen credit spreads and depress the prices of existing investment-grade corporate bonds. If AI CapEx plans are drastically scaled back due to power constraints or hardware shortages, the anticipated flood of bond supply will not materialize, supporting IG bond prices.